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Sunday, September 10, 2017

Blockchain and the Edge of Disruption - Brexit

In August 2017, the British government released a position paper on future customs arrangements with the EU following Brexit. Among other things, the paper suggested that new technology would address some of the challenges of maintaining trade "as frictionless as possible". In his report, the BBC technology correspondent mentioned number plate recognition, artificial intelligence, and of course blockchain. This week I met with a couple of our blockchain experts at Reply to brief me on what blockchain can and can't do to address this challenge.

First, let's understand the nature of the challenge. When goods cross a customs border, they have to be declared. Some shipments are inspected to check that these declarations are accurate. This process has three objectives.

To ensure that the goods don't exceed some import/export quota, and to levy customs duties if necessary

To ensure that the goods satisfy applicable standards and regulations - for example food safety

To identify contraband or counterfeit goods

Importers should be able to submit customs declarations electronically before the shipment reaches the border. This should enable customs officials (or algorithms working on their behalf) to select shipments for casual or close inspection, thus reducing delays at the border.

Note that these processes already exist for goods entering the European single market. But the potential impact of Brexit is a massive increase in the volume of cross-border shipments, and current systems and procedures are not expected to be able to handle these volumes. Goods will be delayed, with implications not only for cost but also the quality of fresh produce. Just-in-time supply chains will be disrupted.

The primary contribution of blockchain here is establish a robust and watertight data trail for goods. This means that if goods are properly labelled, the blockchain can deliver a complete history. This doesn't remove the need for customs declarations, but under certain conditions it could reduce the need for inspections at the border. For example, instead of being located at the border, a plain clothes customs inspector might visit retail outlets with a hand-held label reader, verifying the blockchain record associated with the label, with the power to seize goods and instigate prosecutions.

The blockchain can tell you about the provenance of the
item identified on the label, but what's to stop someone switching
labels, reusing old labels or even cloning labels?

For some goods the stakes are very high. The lost revenue from the smuggling and counterfeiting of cigarettes alone is estimated at €10bn a year. So a Europe-wide system is being implemented to track cigarettes: by May 2019 all tobacco products within the EU are required to be "marked with a unique identifier" and security stamp. So that's just one high-stakes product, with a relatively small number of manufacturers.

For diamonds, the stakes are even higher. The Kimberly Process Certification Scheme (KPCS) was introduced in 2003 to control trade in "conflict diamonds", but there are many flaws in the scheme.

"If a consumer went into almost any jeweller in the UK and asked for the
origin of a diamond on display, staff would most be most unlikely to be
able confirm which country, let alone the mine, it was sourced from." [Guardian, March 2014]

My colleagues briefed me on some interesting innovations they are working on for specific high-value products. One possibility is to inscribe a unique identifier into the product itself. For example, diamonds can be etched with a laser, expensive shoes can have the identifier embedded in the heel. And with 3D printing, it may be possible to manufacture each item with its own unique identifier.

Another possibility is to create a detailed description of each item. Everledger, which describes itself as a permanent ledger for high-value assets, uses more than 40 features, including colour and clarity, to create a diamond's ID. It is now moving on to other high-value products such as fine wine. In future, such schemes should make it more difficult to pull off the kind of criminal sleight of hand for which Rudy Kurniawan got ten years in prison.

To prevent cloning, you need more than blockchain. Just as numberplate recognition fails if people can use false numberplates, so blockchain labelling fails if people such as Kurniawan can easily reuse or copy the labels. At a wine auction in 2006, he offered eight magnums of 1947 Château Lafleur. This immediately aroused suspicion, because only five magnums were ever produced. If he had sold each bottle separately, would anyone have noticed? Yes perhaps, if every sale had to be recorded in the blockchain.

If criminals have access to such technologies as etching and 3D printing, they may be able to create exact copies of labels and products that would appear valid when checked against the blockchain. So to guard against this, the blockchain has to have sufficient visibility of the supply chain to detect any duplicates.

In other words, to use blockchain properly, it's not enough to maintain a record of the origin of an item. You have to have a complete record of all transactions involving the item, including inspections. This means adding to the blockchain at every link in the supply chain. As the industry body BIFA observes in relation to blockchain generally,

"this technology ... can only reap its full benefits if all stakeholders/members of the supply chain make use of the technology and can access it"

Further difficulties arise where goods are processed. For example, when a large animal or fish is cut up into pieces, to be sold to multiple consumers. Blockchain can be used to check that the total weight of the pieces is consistent with the original weight of the whole, but again this assumes that all the pieces are tracked. However, there is considerable interest in getting this kind of scheme to work effectively for products where sustainability is a major issue, such as tuna.

Where there are transformation points in the supply chain - such as cutting a rough diamond into jewels or cutting a whole tuna into steaks - these can be subject to special monitoring and certification, and this can itself be written into the blockchain for further reassurance.

In summary, my colleagues have convinced me that there are significant opportunities for blockchain in supporting the supply chain for selected high-value or safety-critical products, provided certain assumptions are met. Blockchain is not necessarily the whole solution, but works when appropriately combined with other innovations.

But even these schemes will take years to get up to speed. We started with the problem of massive increases in the volume
of shipments crossing customs borders. In the examples I've discussed
here, customs facilitation is not the primary motive for introducing
blockchain, but may be an additional benefit. However, it is hard to see a sufficient number of these schemes being operational in time for Brexit, let alone a universal system for all categories of goods.